If someone could help me with his question from the Wiley Mock A PM I would greatly appreciate it.
An interest rate tree is given. y0 2.6% y1 4.9% 3.5% y2 7.75% 5.48% 4.32%
The strike rate is 4.5%. This is a 2-year annual reset cap and asks for the value of the 2-year caplet at inception.
The answer completely ignores the fact that the strike rate was exceeded in y1 (4.9 > 4.5). Doesn’t “annual reset” mean that the long should get paid for both y1 and y2 since the strike rate was exceeded in both y1 and y2, instead of just y2?